Forex traders with trading gains should elect out of Section 988 and into Section 1256. As mentioned earlier, the tax savings can be up to 12 percent.

However, forex traders with losses may be better off getting the ordinary loss treatment that comes with Section 988. Section 1256 losses can be carried back up to three years, but they can only be offset against Section 1256 gains. On the other hand, ordinary losses can be offset against any type of income.

Unfortunately, traders do not have the benefit of waiting until the end of the year to make a decision. IRS rules require traders to elect out of Section 988 on a “contemporaneous basis.” This means you must make your decision before you begin trading — and before you know if you have gains or losses.

The rules also say the election should be filed “internally,” which means you place it in your own records as opposed to filing it with the IRS. Many traders bend the rules and after year-end, if they have gains, claim they elected out of Section 988 earlier in the year. To learn how to elect, visit www.greencompany.com.

Because currency trading has long lagged behind futures and equity trading in popularity, the IRS has not paid close attention to taxpayers electing out of Section 988. However, with the explosion of online trading forex , the IRS is likely to catch up with these traders.